$\begingroup$Along the lines @SerbanTanasa mentions, the hyperinflation which naturally occurs when you do this hits a fundamental limit when the cost of reprinting bills, in terms of paper and ink, starts to outvalue the currency itself. At some point, the hyperinflation becomes so predictable that it is more cost effective to sell the paper and ink for foreign currency than to turn it into domestic currency.$\endgroup$
– Cort AmmonAug 18 '15 at 5:30

4

$\begingroup$Why would people want this currency? What would make it valuable? If the government demands taxes then the currency is valuable because it can get the tax collector off your back.$\endgroup$
– bdslAug 18 '15 at 13:35

27 Answers
27

It would not work. Think about it for a second. Taxing people, and getting them to actually pay, is hard. Printing money is easier. If it were possible to sustainably fund all government expenditure by printing, governments would never be bothered with taxing, fairness considerations be damned.

As with any asset, there is a supply and a demand for a particular currency. Money happens to be used as a standard measure of other goods, so we tend not to think of it as just another good, but that's what it is.

So, by regulating the amount of currency they release into circulation (and by hanging forgers) a government establishes a relatively stable system of reference for the prices of other goods, which is useful for conducting transactions. Which is why people tend to use money as a universal medium of exchange, rather than cigarettes or shells or large slabs of silver, although they will use these too, if a sound paper currency is not available.

Whenever the government creates more money (POOF✥) the value of the existing stock of money falls. Why is that? Because the amount of goods in the world and the amount of labor that can be done is still the same as it was before the extra money was created. Therefore, having created twice as many Zimbabwean banknotes as before, you'll find that the entire pile of money does not buy you twice as much stuff, but roughly about as much as you could buy before.

Furthermore, people start adjusting their expectations, so if you print money today, they will expect you to print money tomorrow, and drive up the prices in expectation of that. So if you want to surprise them, you'll have to print even more ... which will cause them to adjust their expectations higher and higher and higher, until you have to bring a wheelbarrow of money with you to buy an egg and your bank can't afford to import the ink to print the new bills anymore. This actually happened by the way.

As to who gets hurt the most? At first, whomever has any money saved, since the value of the money in the bank that could buy a car yesterday will buy them only half a car now that you doubled the currency stock. Eventually, the entire country is hurt, capital and brain drain ensues, the price of imports becomes prohibitive for all the locals, a gang of well-connected thugs benefit while teachers and other public employees prostitute themselves on the streets for food, and it all goes down the toilet.

Note that in most modern western states, the government spends somewhere between 30-65% of the GDP. While you might get away with a teensy bit of spending (3% or so), it's unlikely you'd find idiots to hold onto the currency if you're printing literally trillions worth of currency each year. It'd be swiss francs, gold, seashells, cigarette cartons, anything but this currency.

✥ Poof has been mathematically proven to be the sound made by the economy with each round of p̶r̶i̶n̶t̶i̶n̶g̶ ̶l̶i̶k̶e̶ ̶t̶h̶e̶r̶e̶'̶s̶ ̶n̶o̶ ̶t̶o̶m̶o̶r̶r̶o̶w̶ inflation taxing.

$\begingroup$Comments are not for extended discussion; this conversation has been moved to chat.$\endgroup$
– Serban TanasaJan 12 '17 at 13:26

$\begingroup$It might be useful to add the specific end of any government trying to fund their work this way. such hyperinflation must always end. If nothing else stops it, the final nail in the coffin will be the point where the government finds themselves unable to buy the paper and ink required to print the new bills to keep up with their spending. The bills literally become not worth the paper they're printed on, and that seals the fate of the government trying this game.$\endgroup$
– Cort AmmonMay 1 '17 at 23:46

Printing money is effectively the same as taxation, but with far less control and supervision.

First of all, "the government" always "prints money". Actually, in most countries, it's not the government, but some central bank that is usually semi-independent, such as the Federal Reserve in the USA, the ECB in Europe, or the Bank of England in Britain. and the money is not created through physical printing bills, but through loan transactions.

This "printing money" should be balanced by money being destroyed (through loans being paid off, mostly), and economic growth.

When more money is created beyond that balance, you get inflation (either systemic inflation throughout the economy, or sometimes investment bubbles such as the housing bubble of the early 21st century, or stock bubbles). Inflation simply means that each unit of currency (dollar or whatever) will be worth less.

Now what you are proposing is basically that the extra money goes to finance the government, but those who already have money or income (i.e., the population) suffers the loss of value of money.

In other words, the population pays for the government's operation. Which is no different from taxation, just through another means.

Here are some of the problems - and benefits - of using "printing money" instead of taxes to finance the government:

It is very hard to control the rate of "taxation". When given free rein to print money, politicians may end up printing so much money that the effective "tax rate" (or rather, the amount of value lost to inflation) far exceeds what would be collected through taxes. That is basically what happened in Germany 1923, in Zimbabwe, and also in Hungary.

This form of "taxation" is hard to target. Most tax systems have mechanisms to distribute the burden and target the taxes in some form. For instance, cigarettes and alcohol may be taxed at a higher rate. Incomes for higher-income individuals may be taxed at a higher rate than low-income people. One can argue about the merits of this type of targeting. However, taxing through printing money/inflation will be untargeted and erratic. Inflation may end up occurring evenly throughout the economy. In that case, this would be the ultimate flat tax scheme. But inflation may also occur only in housing - in that case, you might end up effectively financing the government through a 90% tax on house purchases. Or inflation may end up causing a stock bubble.

This form of "taxation" can also provide a negative tax on outstanding loan balances. In some situation, that can actually be desirable - for instance, during the housing bubble, some carefully controlled inflation could have provided relief for homeowners homeowners (update: with a mortgage) (specifically, wage inflation would have done that).

Update - I just thought of this: This form of taxation would implicitly tax all money, including "under the table" payments.

Update - I just thought of this: This form of taxation could be avoided by conducting business in foreign currencies, or by bartering.

So, the answer to your questions:

In a society where government issued currency (most current countries)
is used, could the government fund itself by printing money to use
instead of taxing its citizens?

Yes

Would this work?

Yes

If so:

How would this effect the faith in the currency system?

It depends on how carefully controlled this approach is. If you can trust politicians not to do this to excess, then the effects may be manageable.

However, there will always be some negative effect on faith in the currency system, because everybody who uses the currency will know in advance that it will lose value over time.

Which class would be relatively taxed the most?

Depends on how the resulting inflation is spread through the economy. In most general terms: it would affect those who save money, and those who borrow money. Theoretically, it will not affect wage earners (because if inflation is spread perfectly evenly through the economy, wages should go up at the same rate as all other prices). Of course, in the real world, inflation won't spread evenly. If history is any guide, wages won't actually participate in the inflation.

The impact on savers and borrowers is complicated. Those who saved at fixed interest rates before starting this form of taxation will lose the most. Those who borrowed at fixed interest rates before starting this form of taxation will benefit the most.

Those who save or borrow after this scheme starts will see the interest rate spread increase corresponding to the amount of money being printed.

Investors in assets will (again, theoretically - asssuming a perfectly even spread of inflation) neither lose nor benefit, because whatever assets they invested in will rise in value along with inflation.

Investors in derivatives (futures, options etc.) or any time-based assets will need to carefully do the math.

$\begingroup$I'm a little confused by your statement that "there will always be some negative effect on faith in the currency system, because everybody who uses the currency will know in advance that it will lose value over time." To me, this sounds like saying that a sales tax will always have some negative effect on faith in the purchasing system, because everybody who buys stuff will know in advance that some of their money will be lost to taxes.$\endgroup$
– VectornautAug 18 '15 at 6:46

1

$\begingroup$This kind of taxation would certainly make it less attractive to hold onto currency, rather than exchanging it for goods and services, but why would it make people "lose faith in the currency system"? The currency system would just be working the way everyone expected it to.$\endgroup$
– VectornautAug 18 '15 at 6:47

7

$\begingroup$The difference between a sales tax and inflation to fund government is that a sales tax is a one-time tax, while inflation is a continual decrease in value over time. Basically, when you know in advance that inflation is used as a form of taxation, you have to price this future inflation into the value you put on any currency you intend to keep for a while.$\endgroup$
– Kevin KeaneAug 18 '15 at 6:49

1

$\begingroup$I suppose it depends on how we define "negative effect on the faith in the currency". You are correct, the currency system would be working the way everyone expects it to, but "faith in the currency" for many people implies "faith in the stability of the currency", the value of the currency not changing much. Inflation, even if it's predictable, is still a change in the value of the currency.$\endgroup$
– Kevin KeaneAug 18 '15 at 6:52

3

$\begingroup$The name for the indirect form of taxation via the printing of money by a government is "Seignorage"$\endgroup$
– LawtonAug 18 '15 at 20:38

Yes, I think it could. Minting new currency at a constant rate should be roughly equivalent to collecting a yearly tax consisting of a fixed percentage of each citizen's currency holdings.

To see why, consider a very unrealistic toy country. A fiat currency, the dubloon, is the legally mandated and socially accepted medium of exchange. There is no fractional-reserve banking, and dubloons can't be given to non-citizens.

Let's suppose there are $10^{12}$ dubloons in circulation. A poor family might hold $100$ dubloons, while a rich family might hold $10\;000$ dubloons, and an enormous car company might hold $10^{10}$ dubloons.

Having more dubloons means having more power to buy things. For the rich family, it might seem reasonable to offer the car company $500$ dubloons for a new sedan. If the rich family is willing to offer the car company such a price, the poor family has no chance of getting the sedan.

From this perspective, you might say—very roughly—that the poor family controls $1\mathrel{/}10^{10}$ of the country's buying power, while the rich family controls $1\mathrel{/}10^{8}$, and the car company controls $1\mathrel{/}100$.

Now, suppose the government mints $10^{11}$ dubloons and puts it in the treasury. There are now $1.1 \times 10^{12}$ dubloons in circulation, so the government suddenly controls $1\mathrel{/}11$ of the country's buying power. Just as suddenly, everyone else's share of the country's buying power drops to $10\mathrel{/}11$ of what it used to be.

The government can use its new buying power to buy things. It might pay the poor family $5$ dubloons for a month of labor, the rich family $2\,000$ dubloons for some land it wants to build an airport on, and the car company $10^9$ dubloons for a few fleets of buses, mail vans, utility trucks, police cars, disaster-response vehicles, and armored personnel carriers.

After these transactions, and many others, the treasury is empty, and all the new money has been distributed among the country's citizens. The poor family's share of the country's buying power has gone down, the rich family's share has gone up, and the car company's share has stayed the same.

Next year, the government can do the same thing again to fund its operations. It has to be careful, though, about how it redistributes the country's buying power with its spending. If it continues with its current budget, for example, the poor family's share of the country's buying power will get smaller and smaller every year. The poor family might eventually get angry and vote for new government officials, or steal the rich family's car, or lose its home and starve to death.

Although I don't see any reason a government couldn't fund itself this way, I can see many reasons it wouldn't want to.

One is that minting money decreases everyone's buying power by the same percentage, and people might prefer some other way of distributing the tax burden.

Another is that minting money is effectively a tax on currency holdings, and people might prefer to tax other things—like income, labor, consumption, or wealth—instead.

A third is that people would have to constantly adjust their idea of what a dubloon is worth to keep pace with the growing money supply. This shouldn't cause any problems in principle: the government could just tell everyone how much new currency it minted each year, and then everyone would know how much they'd effectively been taxed. It would probably be extremely annoying in practice, though: shops would have to change their prices all the time, dealing with cash would be a huge mess, and it would be easy to get confused about whether $0.01$ dubloons is still a good price for a bunch of bananas.

Disclaimer: I have very little background in economics, and even less in monetary economics, so I'm totally unqualified to answer this question. Input from folks with more background is welcome.

$\begingroup$Nobody "wants" cash. No one goes out and puts money in a picture frame on the wall. Hell, no one even just puts large quantities of cash under their mattress. Either you are spending it, or saving it with interest to spend MORE later. Inflation (hyper- or otherwise) without high interest rates just changes the ROI on spending vs. investing heavily in spendings favor. And Argentina is a useless example. Trying to fix a broken economy with hyperinflation can teach us nothing about designing a system with expected, constant, stable, moderate levels of inflation.$\endgroup$
– ShaneAug 19 '15 at 14:55

1

$\begingroup$Especially considering our system is already based around having expected, constant, stable, low levels of inflation.$\endgroup$
– ShaneAug 19 '15 at 15:04

$\begingroup$@Taemyr, regarding why you might want the money: as Shane noted, many modern currencies experience steady devaluation. My wallet currently contains several Canadian and US dollars, both of which have been falling in value by about 15% to 30% per decade since the mid-1980s. I keep them around because they're easy to work with, and all the traders I'm likely to encounter will be willing to trade stuff for them, which makes them worth the average devaluation of like 0.3% per month. [cont.]$\endgroup$
– VectornautAug 19 '15 at 18:38

$\begingroup$@Taemyr [cont.] In the old days of a world where seigniorage is the standard tax system, government spending of under 30% of the currency supply per decade might have been typical (though I'm not a historian, much less an alternate historian, so I can only guess). Back then, if our world is any guide, people would have been happy to carry cash in their wallets. [cont.]$\endgroup$
– VectornautAug 19 '15 at 18:39

Most of the answers have dealt with the theory of devaluation, which is both sound and has historical examples, so I will describe some of the real world effects, based on discussions I had with both my economics professor, who studied this and people from Argentina who lived through it in the late 1970's (Argentinians are going through something like that yet again, and Venezuela is also suffering from many of the effects of hyperinflation).

As the supply of money continued to grow and inflation began to bite, people began converting their cash into items with real intrinsic value. At first, buying jewelry and other luxury items made sense as it is small, portable and has high intrinsic value, however after a while everyone had a fistful of rings and watches, but were unable to get what they really needed (or the value of the jewelry and other items was mismatched to what they could actually get: a roll of toilet paper is not a fair exchange for a diamond ring under most circumstances).

The other effect was the supply of small luxury items was quickly exhausted, while other goods were in short supply and money was rapidly becoming more and more worthless. Eventually, a sort of barter economy sprang up: people would rush out at payday and purchase literally anything they could get their hands on, and soon streets were full of cars, living rooms with shoes and so on. You could wander the streets to find an item you were short of, but needed some canny negotiating skills or a chain of "exchanges" to get the item you needed (you might have to trade some shoes for a set of dinnerware, then the dinnerware for a sewing machine, then the sewing machine for a TV to get the spare part you needed for your car). You can see why currency is far more convenient than barter, but if the currency is not sound, then some form of informal currency (cigarettes have been popular in some times and places) or barter will eventually rise to replace the devalued currency.

Printing money to fund the government is somewhat like believing in perpetual motion.

$\begingroup$One correction and one comment: even though it had high inflation all through the 1970s and 1980s, the hyperinflation in Argentina was in the late 1980s (mostly 1989). Also, more than exchanging goods what people did was to buy US dollars as soon as they got their paycheques.$\endgroup$
– Martin ArgeramiAug 19 '15 at 11:20

$\begingroup$Yes, I had made an error in my dates, so thank you for that. WRT exchanging worthless pesos for USD is simply a variation of buying shoes or sewing machines the first chance you get, and gives you more flexibility. Sadly for lower middle class or poor people, getting USD was very difficult, and getting barter goods was much easier to do.$\endgroup$
– ThucydidesAug 19 '15 at 23:43

$\begingroup$My salary as a TA at the university in 1989 was the equivalent of USD 10 (in " australes" , then currency). It was trivial to convert those to USD.$\endgroup$
– Martin ArgeramiAug 20 '15 at 3:11

$\begingroup$Based on the conversations I had with my professor, his information was that poor and lower middle class people did not have as much access to banks and currency exchange, hence the reliance on barter. Your situation may be different, and perhaps my information was incorrect, but I haven't heard any other information to the contrary. I would be interested to see an expanded answer with your information.$\endgroup$
– ThucydidesAug 20 '15 at 3:25

$\begingroup$Poor people in Argentina would never set foot in a bank, simply because they don't need to; they are paid in cash. But currency exchange has been always open until the government starting creating barriers 3 or 4 years ago. Anyone could go into a exchange currency place and exchange local currency for USD. My sources are not academic: I lived there from 1968 to 2002 (i.e. from 0 to 34 years old) and since then I have visited 14 times. When I have a little time, I'll write an answer.$\endgroup$
– Martin ArgeramiAug 20 '15 at 3:51

If you have a large economy with little economic growth, you can inject money in the system to stimulate the economy. It might generate some inflation but inflation is something that is almost inevitable anyway. If the amount is not too large, it's manageable and could be beneficial.

Printing money is bad because it makes it less valuable: the value of the currency will drop depending on how much is added in the system compared to the size of the economy. People will want to use your money if they believe it's reliable. If you print a lot of it, the value will drop and people will need to pay in the thousand just for a bread.They will want to use other currencies. All the countries have their own currency (some share a common one like the Euro) and yet the population of many countries use the American dollars instead of their own currency because it's more reliable. If you can't predict the value of your currency because of the high inflation, you are in an economic insecurity and people prefer security.

If you can create money from thin air then it has no value because there is no scarcity.

$\begingroup$In reality or fantasy, the value of printed money can be enforced by law as the only valid medium of exchange; i.e. barter can be outlawed and punishable like any other felony; including execution: whatever it takes to make people reluctant to do it. That makes the money reliable. Just like taxation, or the cost to citizens of complying with regulations, it all depends on how much is printed or how high the tax or how large the expense: Not on the mechanics of how the government extracts goods and services from its citizens to accomplish its functions.$\endgroup$
– AmadeusMay 2 '17 at 12:24

$\begingroup$@Amadeus You can't completely outlaw the effects because the effects are real (like laws of physics) while laws are merely wishes of people. Outlaw barter and you haven't fixed the fact that prices of things rise daily (or by the hour). Outlaw inflation and you haven't fixed supply and demand and there will be shortages of goods. Outlaw infinite purchasing (everyone has a quota) and the value of money becomes worthless because even if you have a million dollars you can't buy what you want (this is basically communism)$\endgroup$
– slebetmanAug 24 '18 at 21:52

$\begingroup$@Amadeus The end logical conclusion if we go down this path is that everyone gets exactly the same things due to quota, you would eliminate distinction between the rich and the poor and the only differences between people is that some have more paper money that they cannot spend than others. The only truly rich entity is the government (exactly the end result we saw in communism)$\endgroup$
– slebetmanAug 24 '18 at 21:55

$\begingroup$@slebetman Laws are not "merely" the wishes of people, they are backed up by bullets, if refusals to obey escalate far enough. Including the law that printed money must be accepted (the law right now!). It is ridiculous to say this results in "communism," it does no such thing. If barter is punishable by death, virtually nobody will barter; they will sell what they have, and buy what they need. The govt could abolish all taxation and print whatever they need to fund operations; the result (and inflation) is equivalent. Assuming runaway inflation is bogus, irresponsible govt is not a given.$\endgroup$
– AmadeusAug 24 '18 at 22:09

$\begingroup$@Amadeus How do you fix goods shortages?$\endgroup$
– slebetmanAug 24 '18 at 22:11

I'm disappointed by how many of the answers so far seem to take it for granted that currencies are supposed to be stable. While it's true that most people in our world expect currencies to be fairly stable, I think that's to some extent a historical accident. This answer is meant as a proof of concept that things could have gone another way. Sorry about the double post.

Of course! Where I'm from, pretty much every nation funds itself this way.

The roots of the system go all the way back to the Age of Heroes, when lords would often award marques of favor to vassals who distinguished themselves by feats of courage or devotion. The earliest marques were little trinkets handmade in a wide variety of styles and materials, often blessed by the lord herself. These tokens of honor were highly sought after, so those who recieved them would often pass them down to their own vassals in exchange for services, in addition to awarding their own marques. Some marques grew in value through fame, or a reputation for good luck. In the 3500s, for example, King Latia gave 60 cut amethysts to each of the seven Countesses of Nome after they rode to his aid during the Hyperborean War. When Nome miraculously escaped the regional plague of the following years, rumors spread that the amethysts were the cause. Their precipitous rise in value helped drive Nome's snowballing political and financial influence over the next century.

An important feature of the favor system was that, with their supply always growing as lords handed them out, marques steadily decreased in value. That meant heroes couldn't rest on their laurels, living off the proceeds of deeds long past; they had to keep up a steady stream of accomplishments in order to maintain their power. Since opportunities for glorious combat were limited, lords increasingly called on their vassals in peacetime to work on civil projects like irrigation and road-building, unwittingly laying the foundations for the great kingdoms of the Times of the Sages. But devaluation had a downside, too: as marques accumulated, and their value decreased, physically storing and trading them became a major hassle. It became common practice for vassals to return marques to their lords every few years in exchange for "new marques," each representing a large batch of the old. Marques became more standardized and mass-produced—no more personal blessings by the lord—and began to be routinely stamped with dates.

At the dawn of the Times of the Sages, feudal alliances were rapidly coalescing into giant kingdoms with monarchs at the top. Most lords stopped awarding their own marques entirely, since those of the monarch and her handmaidens were better respected, and they trickled down reliably from above. They could also be conveniently traded between provinces within the kingdom. (Incidentally, this is why a lot of modern currencies are called the heighmarque, or some variant of that—it started as "the high queen's marque.")

As kingdoms solidified their internal currencies, however, they became more economically isolated from each other. Rulers grew to distrust each other's marques, whose values could suddenly tank if their issuers decided to do an enormous land buyout or launch an expedition to the South Pole. Merchant families stepped in to fill the gap by trading in goods between kingdoms. When they needed cash to kickstart a new trade route, they'd borrow it from well-to-do locals, and the modern banking industry was born. Four hundred years ago, the "bricks" in your TeaBank account (or your Lower Port Province Trade Route account, as it was then called) stood for literal bricks of tea, bought with your deposits and destined for buyers overseas.

Marques got even more mass-produced, turning into dyed wood sticks or paper notes, and newmarques began to be issued on a regular basis. Spending was slower back then, and hauling marques around took more work, so replacement periods of seven, nine, or eleven years were common, rather than the four or five typical today. The world saw its first modern spending crisis in the 4160s, when the Empress of Noba, trying to raise an army for a war of expansion, ended up pricing the kingdom's farmers out of the labor market instead, setting off the Farmers' Revolt.

As the era of mechanization rolled in, nascent manufacturers got into the banking business for the same reason the merchant families had centuries prior. By accounting in symbolic shares of their factories—early Windloom Atlantis accounts were measured in "blades of the windmills"—they introduced the idea that banking currencies needn't be tied to tangible goods. By the mid-4400s, nearly all banking currencies had become fiat currencies, regulated by international trade groups. The transition was not without mishap: banks' formulas for setting the marque values of their supposedly time-stable fiat currencies were often complicated and opaque, leading to protracted court battles and the eventual passage of national and international banking currency rules.

The practice of giving "compensation payments" to poor citizens whenever marque was printed, as a way to maintain the buying power of those with low incomes and little access to banking, had been around since the Times of the Sages. It was only in the late 4300s, however, that the spread of democracy and calls for a stronger social safety net led to a serious study of compensations. Today, most nations have quite involved compensation systems, with price-indexed payments, payroll deductions, and adjustments for assets in the bank.

Our financial system looks a lot different than it did a millenium ago, but some things don't really change. TeaBank still trades a lot of tea, although the cute tea brick icon next to your balance is purely fictional. The High Count of Nome still blows a theatrical kiss over the national mint every Budget Day, so those marques really are "Printed with the Blessing of Our Sovereign." And we're all still hustling to keep up with the marque supply, because no matter how stable our banking currencies are advertised to be, the old saying still goes: "Yesterday's glory won't buy tomorrow's arrows."

I think that answers to this question have already covered lots of scenarios and possibilities. However, I would like to bring my small contribution (a rather theoretical one).

Although I believe that funding government through printing is NOT possible in a real world because of the huge inflation it would cause, it is certainly possible in theoretical terms.

When we think about government spending we tend to think about big government. A government which provides welfare and utilities to its citizens. However, imagine that you have a small government which does not have a welfare system, lots of agencies such as FDA, inefficient businesses such as subsidised public transport, etc. The expenditures of SUCH government (which I don't think exists anywhere in the civilised world) would be very little.

Provided that you have such little government, you can certainly fund its operation by printing more money at least during some stages of economic cycle. And here is why. Increasing money supply does not necessarily lead to inflation. As an example, imagine that you have a closed economy where there is only one good (milk) and the overall amount of money is X. Now imagine that productivity increases and the amount of milk doubles without the increase in the amount of money. Obviously, it's price goes down and you get deflation. If, however, the quantity of money increases, the result can be stable prices.

So, increasing money supply will NOT lead to inflation provided that this increase corresponds to the increase in productivity of the economy.

It is therefore certainly true that you CAN fund the government with printed money and without causing inflation. However, this is only achievable if the increase in quantity of money matches increase in the productivity of the economy.

Which, obviously leads us to conclude that it is not a feasible system. Because it is inevitable that at some point the productivity of the economy will decrease (due to some natural disaster or some other reason). You'd have to shut the government and wait for the productivity to restore before you would be able to print new money without causing inflation. And that is not very feasible :)

$\begingroup$I don't think the down cycles would be a big problem--go ahead, print money during the down cycles, it will average out with the up cycles. So long as you don't print more money than the desired rate of growth of the money supply you won't harm your economy. It's just this makes for a very small government!$\endgroup$
– Loren PechtelJan 10 '17 at 23:27

This depends on what you mean by government. For example, Emperor Norton I of the United States funded his activities in exactly this way, and suffered no ill effects. (From his Wikipedia article: "Norton also issued his own money to pay for his debts, and it became an accepted local currency in San Francisco.")

But, you say, you expect more from the government than an amiable figurehead. Fair enough. Consider the Post Office. It prints fungible promissory notes and uses them to fund its operations. (The fact that, in the current system, they're exchanged for currency is a minor detail -- in principle, they could be directly exchanged for goods and services.) Pratchett has a nice exploration of the relationship in Going Postal. The government could expand to other services that are self-financing. For example, banking would be a natural fit, and indeed history provides many examples of private money issued by banks, despite their not have the ability to tax.

If you're planning to finance a government this way, I think the currency would have to self-destruct quite quickly, and also perhaps be intrinsically useful. There's an informal economy of moon cakes that emerges every year in China, for example.

Finally, I think the other answers to the question overlook the fact that currency has value -- that's why it exists. Even in prisons and POW camps, a medium of exchange tends to emerge, and people will trade for the medium of exchange at a premium to its intrinsic value, because they value its liquidity. That premium wouldn't pay for very much government, but it would buy some.

So, in summary, it could work for very limited values of work and somewhat broad definitions of money.

No

TLDR Taxation is the mechanism by which money GAINS value. Or the tax man is why I don't have piles of money at the end of the year.

Most answers here deal with the historical fact that printing money would cause inflation, leading to the currency being worthless.

I contend that all of these answers are fundamental wrong, because you cannot devalue something that is worthless.

Fiat currency

I assume that the OP is talking printing fiat currency and not a secured currency, since you can't "just" print them.

Historical all currencies were secured, because a piece of paper with a number on it is pretty worthless.

Fiat currencies are a relatively new invention and have only appeared in relatively stable governments and economies. Because these are needed to give value to the currency.

There must exist a mechanism of linking your fiat currency to some utility, which is universally valued.

In the system we have in the western world, that utility is called freedom, and the mechanism is called taxation. By equating x dollars to y freedom each year by taxation, all people who need freedom will value x dollars as being y.

This also explains why only stable economies/governments can produce fiat currencies, as unstable governments might lose the capability to deprive you of your freedom when you fail to pay tax.

$\begingroup$While some of the other answers here are correct-ish, this one absolutely hits the crux of this issue. Except for the requirement that dollars must be used to deal with the government, they would become immediately undesirable as a unit of trade.$\endgroup$
– TruthAug 20 '15 at 17:38

$\begingroup$Logically speaking, this comment makes assertions not in evidence. (a) Fiat currency obviously has value if it is widely accepted as payment for goods and services. There is no universal object like gold that is always valuable; you can't feed your children gold. (B) "freedom" is not a utility; guaranteed acceptance is. (C) Taxation causes just as much inflation as printing money; see my comments on this thread. It doesn't break down because of inflation; our inflation has been about 1000 fold in the last 200 years, but we still operate fine, as long as wages inflate apace with prices.$\endgroup$
– AmadeusMay 2 '17 at 12:14

$\begingroup$@Amadeus While taxation can cause inflation it is not "just as much" as printing money. Printing money is around 100 times more damaging than taxation. Some of the older generation in my country still remember the crazy inflation the Japanese caused by printing money.$\endgroup$
– slebetmanAug 24 '18 at 22:02

$\begingroup$@slebetman You will have to provide a neutral source to prove that to me. There is no mathematical difference. Japan caused runaway inflation because they printed money irresponsibly, and irresponsible govt is quite common, but not a given. The govt takes 40+% of my gross pay by various schemes and taxes (income tax is the largest but I also pay property tax, sales tax, gasoline tax, license fees, etc). I don't believe your assertion of "100 times", or even "2 times". They will spend what they will spend, period, changing where they get that amount won't matter.$\endgroup$
– AmadeusAug 24 '18 at 22:16

$\begingroup$In our world, most governments have not only the sole right to print money, but also the sole right to destroy money. That means there can't be "very litle money in use": all the money the government prints will remain in circulation unless the government destroys it. In fact, there will probably be lots of money in use, because people will be throwing money around as fast as they can to avoid holding onto it.$\endgroup$
– VectornautAug 18 '15 at 17:55

$\begingroup$@Vectornaut, most "money" is created by bank lending out deposits, the people that get lend the money, then puts it in their bank accounts, so letting the banks lend out the same money MANY times. Physical money is only a very small part of the system.$\endgroup$
– Ian RingroseAug 18 '15 at 20:16

$\begingroup$True—but for the purposes of this question, one needs to distinguish carefully between money and currency. The OP is asking about a country where the currency is expected to devalue steadily, so banks probably wouldn't store value in the form of currency. That might mean most of the money created by fractional reserve banking wouldn't be in the form of currency either. In other words, fractional-reserve banking might have a big effect on the money supply, but a small effect on the currency supply.$\endgroup$
– VectornautAug 19 '15 at 1:26

$\begingroup$@Vectornaut Governments have the right to destroy paper, not money. Did your bank account decrease yesterday? Because your government surely burned the money you deposited into your bank account. The paper is destroyed. But if they destroy the value as well we'd have a revolution on our hands$\endgroup$
– slebetmanAug 24 '18 at 22:04

$\begingroup$@Vectornaut Banks don't need paper currency to store value. Most of the money in banks are burned by the government. Banks just store numbers in books (computers). Generally banks get just enough new paper money to meed demand from withdrawals. In some countries like China banks keep almost zero paper money because the population has stopped using paper currency in favour of mobile apps (yes, in china you cannot survive on cash because a lot of shops no longer accept paper money)$\endgroup$
– slebetmanAug 24 '18 at 22:08

Most of this has been covered by the other answers, however one thing has not been touched on.

Who would be affected by this?

Poor people? Not really. They have no cash reserves anyway.

Rich people? Maybe. They tend to have their money tied up in fixed assets though. It's all in shares, property, etc.

Everyone in the middle? Ahh, that's the problem. Everyone with savings. Everyone trying to save up for retirement with a pension. Everyone who has enough money coming in to put a bit aside for a rainy day, but not enough to buy investment style assets. Those are the people who suffer.

$\begingroup$It certainly wouldn't be a popular policy move in our world, where most people agree that the value of money ought to stay relatively stable, but this is a worldbuilding question. In a society where everyone took it for granted that the government funds itself primarily by printing money, I doubt anybody would keep their savings in the form of currency.$\endgroup$
– VectornautAug 18 '15 at 17:49

$\begingroup$There would be some currency in your checking account, of course, and you'd have to convert a bunch of your savings to currency every time you wanted to make a big purchase, but I imagine your savings themselves would be in the forms of stocks, bonds, commodities, land, or weirder things.$\endgroup$
– VectornautAug 18 '15 at 17:49

$\begingroup$@Vectornaut Once things have adjusted, yes most likely. Savings would have to be held in forms that are not money. But that doesn't change the answer or invalidate it. People with money in conventional savings are the people hit the hardest.$\endgroup$
– Tim B♦Aug 18 '15 at 18:25

3

$\begingroup$Oh, I think we're reading the question differently. I'm imagining a world in which this is the normal way to fund a government, and has been for as long as anyone can remember, just as our tax and monetary system is to us.$\endgroup$
– VectornautAug 18 '15 at 18:29

Most of the answer are more of less accurate but there is a slight confusion of the way Central Banks do work.

First point: Increasing money supply

Money is just another good, and answers to the same laws. If you increase the quantity of money available in relation to the goods that can be purchased, inflation will appear. This is not related to how the "new" money is being used.

Note that increasing money supply is printing money but also allowing banks to lend more money. In present day, most money is not physical but a number in an account.

To put this into numbers.. if your country only produces bread bars, and this years production is 110% than that of the last year, money supply this year should be at least 110% than that of the last year just to keep prices stables. If no extra money was added, you would get deflation which is a very bad thing.

Inflation usually hurt rich people more than poor people, by the simple reason that rich people have more money that is losing value than poor people. Inflation also helps people with debts (with more money in circulation, prices and wages will rise making repaying debts eaiser) and damages creditors (the value of the money when they got it back will be less).

Moderate inflation is generally good for the economy, because it puts pressure in money holders to invest their money to get some profit that allows them to, at least, avoid the loss of value. Otherwise, they could just store the money in a vault. In terms of economical crysis, an increased money supply will bring some extra inflation but will help revitalize borrowing and the formation of new investments (people being more afraid to invest, they need a bigger "stick" to punish them if they don't do).

Hyperinflation is bad because there are no investments that allow to keep the money value, so people just buys valuable items (gold, land tracts, etc.) and uses them for no productive activity, they just expect them to increase their value due to the hyperinflation.

Second point: Funding government

So now, to the question... if you are going to increase money supply: why not use that money to fund the state directly? It sounds easy enough.

The main issue is that it is, effectively, easy enough. Too easy. Inflation is an invisible tax that hits people indirectly. You need to win next elections? Lower taxes 10% and print more money. People will vote you because their tax form shows a lower number, and criticize the baker because the bread is more expensive. The following elections? Well, let's lower taxes 10% again...

Given that a modern government and public sector may take up from 20% to 50% of GDP, and GDP usually rises in single digit percents, trying to fund fully with extra money will lead to hyperinflation. And trying to partially fund it leads to the above explained slippery slope...

In some countries Central Banks are not independent of the Government, and their actuations are always watched cautiosly. Investing in Chinese funds may mean that the Chinese Central Bank decides, for political reasons, that the yuan must be devaluated, and result in a surprise for the investor.

So, usually Central Banks are set as independent entities to avoid that sort of "direct" political pressures. Unfortunately, they are still sensible to indirect political pressures (mainly from the rich people with access to them, and to which inflation fighting is the only role of the bank in order to preserve the value of their money).

$\begingroup$If you managed to have a society where government spending was only a few percent of GDP this might actually be a good system. No tax collection bureaucracy, no tax system for people to game. I don't think this could actually happen without a far more high tech society than ours, though.$\endgroup$
– Loren PechtelAug 20 '15 at 0:33

$\begingroup$@LorenPechtel The issue with that is that Central Banks sometimes must withdraw money from the system (if inflation runs too high, or if GDP decreases), and in those time the available money for the government would be 0 or nearly 0.$\endgroup$
– SJuan76Aug 20 '15 at 0:46

$\begingroup$You could go with borrowing at such times.$\endgroup$
– Loren PechtelAug 20 '15 at 1:39

If a small country can successfully print large amounts of a large currency ($, €) (a.k.a. counterfeiting), and get away with it, it can use this to import goods.

That's a pretty big if, though.

Of course, it also means war.

How would this effect the faith in the currency system?

If successful, the faith in the currency system would be destroyed. Counterfeiting money is illegal and if a foreign government does so it is effectively an act of war. If this money gets circulated, people can no longer tell apart money.

Which class would be relatively taxed the most?

Other answers have covered this. It's basically the same as if the money would be properly printed by the domestic government.

$\begingroup$North Korea has a long history of counterfeiting other countries' currencies, in amounts that were a significant part of North Korea's trade balance. And yes, North Korea is theoretically at war with most of the world.$\endgroup$
– JasperMay 3 '17 at 19:50

Yes, printed money can be used to fund government spending ad infinitum without inflation and no taxation as long as money can be equivalently removed from circulation without taxation.

If we define an interest rate on government insured savings deposit as being distinct from taxes and social benefits, then money can be removed from circulation without taxation by setting the interest rate on savings deposits below zero. Such savings must be deposited at the government bank. Deposits at private banks are not considered money and if the bank goes bust so do the savings.

The money the government receives by the negative interest rate is not spent - it is deleted. A positive rate can be used to inject extra money above fiscal spending.

So that takes care of regulating the quantity of money, but the issue of demand for government money still remains.

As other answers have noted, taxation creates a demand (pay up or go to jail). However, any government monopoly service that is in high demand and can only be obtained by presenting government currency will do. So for example, healthcare, life extension, licenses to have children, license to avoid being sent to the soylent plant, license to carry on a registered profession, advanced education, access to a city state etc etc.

Its a bit of a dystopia of course, unless you can come up with a genuinely welfare enhancing public good that in your world is only really practical to provide from the public sector.

Arguably a negative interest rate is tax on money of course, however if that were true then a positive interest rate is a "social benefit" paid to holders of money, which is not how interest is normally presented. It all depends on the cultural mores of the world setting in question.

Printing money does cause what we call "inflation"; because when the government uses printed money (which it gets for free) to build a fort, it is taking products and labor out of the marketplace. That reduces the supply of the products and labor, so whatever the demand for it may have been, with a lower supply of it, we expect "normal" citizens without access to free money to have to pay more for those products and labor.

Of course the effect may be minimal, the change may be less than, say, one percent, in which case the seller may not bother to raise the price at all. It may also be non-existent; the government may print money to buy a portion of a perishable product that would have to be discarded if not used: bread, milk, meat to feed the soldiers. If there is an excess of a perishable product, the ramifications are complex but in the end, prices may change but there is no inflation, per se. Somebody got paid for efforts already expended that otherwise would have gone unrewarded.

The main point I'd make is that taxation indirectly causes just as much inflation as printing money. IRL I work a job for a certain amount of take-home pay. I insist upon the take-home pay. About 40% of my gross pay goes to various forms of government income (including sales taxes, property, licensing fees, etc). If that should increase, I would demand a raise to maintain the same take-home pay, my employers would raise their prices to cover their greater expense (or lower their own profits), their clients would pay more -- Price Inflation.

The same can be said for regulation: Raise the minimum wage, prices will go up and/or profits will go down to cover it; that is inflation. Even people with savings lose purchasing power; because a $100K in savings buys less stuff when the prices are higher. IRL every product we buy in the USA has this kind of taxation/regulatory overhead built in to its price, we just don't see it explicitly and so we don't know the percentage. But it could be half the price we pay, easily.

Printing money to pay for government is a perfectly viable means of funding the government instead of taxation. The issue is, like taxation, still controlling how much money the government is allowed to print, which is equivalent to saying what exactly are the legitimate expenses of the government.

In all instances (printing, taxation, regulation) the government is taking something for free from its citizens in labor and/or property (and/or lives in conscripting soldiers); ideally in order to realize some kind of collective action that pays off more for its citizens than they could realize alone. Like, building a collective wall around the village to repel invaders, or providing for a full-time healer, wizard, army or brew master that serves them all! Or road building, trade protection, etc.

The problems of "inflation" only arise when the government is consistently taking far more from the citizens than they (collectively) get in return; when the value taken is wasted on the government's own entertainment, indulgences and petty squabbles (including wars that gain citizens nothing).

But that can happen no matter how the value of their property, labor, time and creativity is transferred from the citizens to the government for free.

The described situation is exactly equivalent to the government running a deficit equal to the new money created.

It would work, so long as the amount if new money issued is <= the rate of growth in productive capacity. In this situation, private net savings as a fraction of GDP (sometimes known as public debt to GDP) would remain constant. This budget constraint on the state will lead to very small public spending (3-5% GDP or less). An increase in private debt levels will also lead to greater inflation further constraining the ability of the government to spend, while a decrease in the level of private sector debt (or increase in the savings rate) will allow the government to spend more than it otherwise would. In a non closed economy, there are also the trade and financial flows with the overseas sector to consider.

The value in the currency comes from the need to repay loans, maintain a level of savings and/or pay taxes (also from it's use as a medium of exchange). Inflation occurs when the economy attempts to purchase more than it produces. An increase in productive capacity leads to deflation, issuing of currency by government counteracts this. New bonds are issued to the government in order to maintain interest rates according to central bank policy (if the government didn't issue them, interest rates would drop to zero, something taken advantage of in the US Federal Reserve QE program, where the reserve buys bonds to take them out of the financial system).

A good example of this is the United States, which has been running a fiscal deficit for decades and currently has quite low inflation rates. If productive capacity declines or the economy runs short of some resource, the hypothetical government will have to cut spending, implement taxation or even run a surplus.

In the case of Zimbabwe, they shot many of their farmers causing a shortage of food, leading to the importation of what was a major export commodity, and in turn to a shortage of foreign currency. Once inflation took hold, the disruption of economic activity and capital flight continued to make it worse.

As for who is affected, the spending leads to high prices than would be the case without it - people trying to save money or pay off debt (i.e. by selling something of value) will be at an advantage when the government net spends, people trying to spend their savings or take on new loans (in order to buy goods and services) will be disadvantaged. The fortunes of those holding a steady amount of savings or debt will depend on the net interest rate (interest - inflation).

$\begingroup$In historical terms, the U.S. inflation rate is quite high. During the past century, it has been much higher than the century-long inflation rate in any hard-currency era since the fall of Rome. (Even the sixteenth century, with the Spanish conquests of silver mines in Mexico and Peru, did not have such high long-term inflation rates.)$\endgroup$
– JasperMay 3 '17 at 19:55

There's a point that I think has been missed in other answers. The way government-backed money gained acceptance in the first place was because it was the only thing that could be used to pay your taxes, and so everyone had to have some of it, and therefore had to accept it as payment for goods and services. If you're not taxing anyone then you can't require them to use your money at all, and if you're continually devaluing it by printing more of it then no one will -- they'll use foreign currencies (probably the US dollar if your country is in east Asia or the Americas, or the euro if your country is in Europe, Africa or west Asia) or even private currencies instead. So you'll end up printing money that no one will accept, and the government won't be able to fund itself no matter how much money it prints, because the money will just be waste paper.

So oddly enough, the problem with your plan is not that the government is printing money, which can be managed; it's that you're not collecting taxes from people.

If done right, in very particular circumstances, it can work very well.

(Short version: if you print money to fund investment which creates new wealth, as opposed to simply moving existing wealth around, then it can pay for itself.)

Imagine I find a bar of gold. I'm richer of course, but only by making all the other gold owners slightly worse off. Finding gold is pretty much a zero-sum game for the entire economy. There is a small increase in overall wealth I guess, due to the industrial uses for gold. But really nothing important. We go to great lengths to dig up gold and then immediately rebury it under our central banks.

But imagine I find a perpetual motion machine, or imagine I'm living in 15th century Europe and I find evidence of the existence of America. In that case, as well as more wealth for myself, the total wealth of the world economy has increased. (There will be winners and losers of course, current oil producers wouldn't like the perpetual motion machine. But many more winners than losers)

Good government policy isn't simply about moving wealth around, but about creating new wealth and increasing the total welfare.

So, imagine I'm an explorer but nobody will believe me that a new continent exists. I try to borrow money to fund the exploration, but nobody is willing to lend it. I decide to counterfeit the money (i.e. printing money, literally) to fund my exploration. With my 1 million dollars I fund my trip. When everyone believes me, they see that world wealth has increased by 2 million dollars and that I own it all.

I generously sell my shares for only half the fair price, collecting $1 million to retire. Everyone is is very happy, they get access to a new continent and they bought it at a bargain price.

Eventually, people notice that I used counterfeit money and I am arrested. But now I can simply offer to swap all the counterfeit currency for the real money I received in my sale! So everyone else is happy and I've got my fake currency back. Of course, now I am required destroy the currency.

In the end, I'm no better or worse off than I was, but the planet is better off and all the counterfeit money has been destroyed. In fact, it would have been unethical for me not to have printed the money.

PS: This is the normal way governments fund themselves, they just wrap it up in other ways.

Solely? No. For reasons already discussed, if there's no demand for the money printed, it inflates to worthlessness. It can certainly work on moderate scales so long as normal levels of taxation are maintained to ensure a demand for the money. It becomes a slightly odd form of redistribution.

What's a more fundamental problem, and the real reason behind the Weimar and Zimbabwe collapses, is that you can't print foreign money. A government can redistribute resources within its borders up to the limit of its citizens tolerance, but it can't redistribute resources into its ports and across its borders. In the case of Weimar, the country had to pay a substantial part of its GDP in gold reparations to France.

$\begingroup$In a world where printing money was the normal way to fund your government, I don't think not being able to print foreign money would be a problem. I imagine that, to maintain economic ties, governments might adjust their spending to keep their money supplies growing roughly in step. A country with a stagnant money supply and what we think of as a "normal" tax system might find it hard to trade with other countries, because to everyone else, its currency would appear to be undergoing constant, catastrophic deflation.$\endgroup$
– VectornautAug 18 '15 at 18:03

Physical currency is not of itself of any value. A countries currency is a token of its reserved wealth. So, theoretically, if I give you a 1 dollar note, I am not only giving you a piece of paper, but I am granting you ownership of a fraction of one of the gold bars in the federal reserve.

The value of a nations dollar is theoretically always in proportion to the amount of wealth they hold.

So, in a micro country example, there are 5 people in the country. That country has 1 gold bar and 5 dollars. Each person has a dollar, each person has 1/5th of a gold bar. If I were to print off 5 more dollars, and 4 members gave their second dollar to the fifth member, we would have 4 people who have wealth equal to 1/10th of a gold bar, and the 5th person now holds 6/10ths of a gold bar.

Printing off too many dollars relative to your actual wealth devalues your dollar considerably, and your currency becomes worthless in import/export, which drives up the cost of the things people are trying to buy with their dollars.

China wants 1/5th of a gold bar for a box of tea. When there were only 5 dollars, China sold us a box of tea for 1 dollar. Since we printed off 5 more dollars, now China will only sell for 2 dollars, so the 4 people who still have a dollar can no longer afford a box of tea with that dollar because of inflation.

Probably incoherent and partially wrong at some point according to an econ major. Thats just how I understand it.

ON the topic of who is affected: The people most affected by this scheme are the wealthy; just like they are the most affected by inflation.

Because the wealthy own most of the debt in the world, they make the most loans with their reserve cash. At least IRL the majority of this debt is at simple interest with a fixed payment; like mortgages and bonds. So inflation reduces the buying power of those payments. Over the course of 30 years, typical inflation of 3.5% per year reduces purchasing power of \$1 to 36 cents; and wages inversely so (\$1 to \$2.80). Inflation is like a "tax" on the rich for money reserves; and they are the primary class of people that keep most of their net worth reserved in the form of funding interest-bearing loans and other such instruments.

If your fantasy world does not contain such an upper strata of wealth with saved money that makes loans and investments, if that is not part of your world design, then funding with printed money need not have much effect on anybody. REAL property, like land, swords, furniture, houses, castles, bridges, and so on, will retain their value; meaning they should sell at their inflated price, for at least as much purchasing power as they cost (minus perhaps wear and tear). It is only the money instruments that are degraded.

ON THE POINT of faith in the currency: If you are going to print money, you have to enforce the use of your money in trade, or at least the vast majority of trade. You cannot allow other forms of money, or extensive bartering, or gold ounces or other forms of accounting systems. If people can live their lives without your official money, then the government has to resort to coercion and conscription for its supplies and employees. Enforcing the use of only the official money for all trade is a small price to pay so that the government can print money and pay people fairly for their land, goods, labor, military service and creative efforts. The degree to which you enforce the use of your money, is the degree of faith in the currency: I can believe my pay will be good at the grocer because if my grocer refuses to take it in payment, I can report him as a criminal.

No, and hang on a second to see why the question doesn't really make sense.

We're talking about fiat currency in the current era. This isn't backed by any hard asset (at any ratio), so it's not what people would have historically called 'money'. In actual terms, it's a debt instrument.

When somebody buys a treasury bill, for example, they're expecting to get that money back with interest in the future. So, it's a loan with repayment, in simple terms. Like any loan, the lender wants to see some collateral. In the case of all modern fiat currencies, the collateral is the ability of the issuing government to tax that repayment out of the people in the territory it controls, using violence if necessary. That's why some religions keep their savings in gold instead - the currency notes in a fiat government system can be seen as exchanged and traded threat promises, in a mathematical sense.

Now there's some gamesmanship that goes on as well, and a bit of a confidence game. When a government racks up big debt, they're extending those promises far into the future. At some point they're promising to extract resources from people who haven't even been born yet to make the mathematics "work". If the music stops, you wind up with a situation like is going on in Greece, where the debt cannot be repaid through taxation, and the government defaults (or gets a bail-out from other countries, which is similar). IIRC the current US debt is on the order of $1.2M per family, which isn't possible to tax out, so the debt is extended into the future, with promises that somebody else will make good on it (somehow). Plenty of smart people are skeptical that it will be possible then, but as long as lenders are willing to keep buying long-term debt, the system perpetuates.

So, asking if money can be printed without taxation, today, is asking if promises of taxation can be done without taxation, which invalidates the hypothetical because it's self-contradictory.

$\begingroup$The promise is not necessarily a promise of future taxation; obviously it can be a promise to print more money in the future. Certainly IRL we have byzantine methods of getting printed money into circulation; but in this question it is about an alternative reality designed from scratch, in which the government just prints money and uses it to pay its bills. This actually requires no T-bill loans or anything else; why bother? Just print the money that would be loaned! Alternatively the government could just gradually print the payback amount over many years, and pay it off that way.$\endgroup$
– AmadeusMay 2 '17 at 14:07

Printing money instead of collecting taxes would work as long as the amount printed every year is no more than what would be raised by collecting taxes, say as a percentage of GDP. Moreover, a mechanism would have to be put in place to eliminate from the economy an amount equal to the money printed, say a decrease in salary. Lots of ifs but done that way you could reduce government spending by eliminating resources used to collect that money. Another other benefits could be eliminating the black market. A government could also control the influx of money by eliminating, reducing or charging for some services.

Obviously, this is a very rough idea and that an awful lot of thinking would have to be expanded to iron out all the details.

I am just an average Joe bloe that thinks that there has to be a better way to raise the money required by a government to fund his expenses.

The idea is to produce collectors' coins with a high nominal value that are bought by collectors worldwide, but never circulated. The problem is that the coin collectors are a limited group spending limited resources to maintain and enlarge their coin collections. So, the collectors' programme must not be to huge (collectors go away when they feel exploited by an inflated collectors' programme) and the potential gain of money is limited.

Paper money has no intrinsic value. A "bank note" is valuable because a bank is promising to accept it as tender. US dollar bills are valuable because the law says you can always use them to pay your debts to the US government. In a system where the central bank has no assets such as gold reserves that can be exchanged for banknotes and the government is not taxing its citizens, this state's paper money becomes useless very quickly. Plus, there is issue of supply and demand. Higher the supply lower the value. With every batch of money you print, what is in circulation becomes less valuable. Also called inflation. Very soon, people will prefer to barter instead of using your money that is guaranteed to be worth less tomorrow.

How long, how badly, and how barely, it would depend on the situation of your economy, previous to such inovation.

The magical/sacred equation of monetary policy - the one economists repeat as a mantra, their everynight prayer to Mammon - is this small piece of elegance:

MV ≅ PQ

in which M is the amount of circulating money, V is the speed (velocity) of money circulation, P is the general level of prices, and Q is the total value of everything produced in a given economy.

Your hypothesis is basically increasing M:

MV ≅ PQ ---> MV ≅ PQ

Problem is, if you increase M, then one of these three things must happen: V will decrease, or either P or Q will increase. (Evidently, it could happen that V will decrease a little, and P and Q will increase a little. But let's go with the "pure" cases).

First, perhaps V decreases:

MV ≅ PQ ---> Mv ≅ PQ

This first possibility is not well studied; economists usually assume that V is inelastic, or that it will only change due to specific changes on the technology of circulation (such as the introduction of paper money or virtual money - and these changes would usually go in the way of increasing V).

So, in practice, economists will offer a few human sacrifices to Mammon in order to get

MV ≅ PQ ---> MV ≅ PQ

in which the increase of circulating money translates into an increase of production. In fact, with very few exceptions, governments do exactly this to a point, with much caution, in order to get their economies to grow (because a static M will make growth very difficult).

But Mammon being a capricious god, what you are more likely to get is,

MV ≅ PQ ---> MV ≅ PQ

in which, instead of production growing, prices rise.

This will allow us to answer the questions, "how long, how badly, and how barely" would this work, as long as we understand how Mammon decides between the increase in P versus the increase in Q.

Prices are relatively easy to increase, especially if the economy is considerably oligopolistic, and especially in the case of products whose demand is inelastic (if the prices of, say, videogames, rise, people can buy less videogames - the demand is elastic - but if prices of food rise, people will have to pay more or starve - the demand is inelastic). Production is much more difficult to increase, because it will demand more investments. Surplus money is one condition for investment, but there are others. And investments' returns may be delayed in time; even if entrepreneurs decide to invest, thus pointing to an increase in Q, it may be that the increase in Q is only going to happen once their new factories or new machines are functioning, which may be several months to a few years into the future. Which means that P will tend to rise in the short term, even if there is investment.

So, we can see that an increase in M will more likely result in an increase in P if:

The economy is already functioning at or near at the limits of its capacity.

Conversely, an increase in M will more likely result in an increase in Q if:

The degree of monopolisation of the economy is low;

The economy relies heavily in elastic goods;

The economy is functioning far from the limits of its capacity.

So, a heavily industrialised but not very heavily oligopolic economy that is just coming out of a recession will probably respond quite well to your scheme, while an oligopolic economy heavily based in agriculture that is already overbusy will probably go into inflation - high inflation - hyperinflation - political crisis very quickly.

Then the problem is that, even in the first case, the growth of the economy caused by the expansion of M itself will eventually make it come closer to its capacity. As long as production can be increased by simply hiring more workers for longer hours and increasing the intensity of the use of machines - additional shifts, for instance - things will go relatively well. But at some point, further increases will demand more or newer machines or bigger factories, and this will only result in an increase in Q in a longer term than what is needed for things to go smoothly. At this point, inflation is going to be unavoidable.

And then the government will want to reintroduce taxes, but this is going to be much more difficult in an economy already facing serious problems of inflation.

And then, it depends of what you call "printing money".

Because actually printing bills, or coining coins, is only a small part of monetary policy, and bills and coins are a quite small part of actual circulating money, so expanding them will probably have little effect in the economy as a whole (see, for instance, definition of M0, M1, etc and money supply in India). When a government really wants to expand M (which, at least in part, means it wants to fund itself through monetary policy) it expands credit. Central banks lend money to commercial banks, and allow those banks to re-lend money to other economic agents (generally, firms and families), but it imposes a reserve requirement that limits the creation of new virtual money by banks. When a government wants to expand its circulating money, it reduces the reserve requirement, which in turn makes credit easier and cheaper, which has either the intended result of economic growth, or the much feared result of inflation.

This brings an additional problem: since any abrupt increase in reserve requirements will probably precipitate an immediate monetary crisis and a recession, governments tend to try to reduce the money supply by borrowing money back, thus reducing the amount of circulation money. But this can cause the government to increase interests too much, and get caught in a vicious cycle: borrowing more money at higher interest rates to decrease M, and then having to increase M in order to remain potentially able to pay back its debts (the kind of conundrum that used to recurrently plague Brasil up to the end of the 20th century, for instance).

If so:

How would this affect the faith in the currency system?

Potentially, it could destroy such faith, through hyperinflation.

Which class would be relatively taxed the most?

All those who rely on relatively fixed prices: workers first and foremost, landlords, especially urban owners of for-rent aparments; also importers (who will find the foreign currency the need to import goods ever more expensive).

In short, it is not exactly a good idea; taxes are more reliable, have less negative effects, and are more easier to scale down (and politically much more difficult to raise if necessary).

If M were to increase based on a set formula (18% of GDP) and politicians were constrained by this, then it would work. The severity of the constraint is the key. Without a sufficient constraint, the scheme would fail.

V would increase as people would retain 100% of their earnings and be able to invest or spend those additional earnings. Barter, black market, shadow economy, all would be captured by this system. The increase in productivity from the elimination of the tax compliance, IRS, artificial incentives and disincentives, etc. would be a boon for GDP growth.

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– JBHJul 24 '18 at 5:42

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$\begingroup$Can you detail a bit more the reasoning behind your answer, and why precisely 18% of GDP? Somebody in ECB or in Federal Reserve might be interested...$\endgroup$
– L.Dutch♦Jul 24 '18 at 5:46